Data shows commercial investment down year-over-year, but there is reason for optimism
Recent data from Altus Group found that commercial real estate investment in the Greater Toronto Area in the third quarter of 2020 fell 23% compared to Q3 2019.
Despite the striking year-over-year drop, Altus Group’s vice president of data operations, Ray Wong, told Mortgage Broker News that commercial activity in the GTA is on the rebound.
“It’s getting better,” Wong said, referencing the 30% quarterly increase in CRE investment in the city in Q3. “When you look at the momentum, it’s heading in the right direction, with investors continuing to look for opportunities and acquisitions. We were expecting, based on the pandemic and some of the re-evaluation by some of the owners, that transactions would be down a lot more than 23%.”
Total Q3 commercial investment in the GTA was $4 billion, led, overwhelmingly, by the land sector, which accounted for $1.8 billion, or approximately 45% of total investment volume. Even though ICI [industrial, commercial, institutional] and residential land investment were down by 40% and 15.6%, respectively, Wong said the decline in activity is the result of a lack of available product on the market, not dwindling demand.
“We have a lot of land, but whether or not they want to put it on the market is another story,” he said, adding that land sales are also being limited by differences of opinion on pricing.
“One of the challenges that we’re having in this marketplace is the bid-ask gap between purchasers and vendors,” Wong said. “Vendors are expecting a certain price for the land and the majority of investors on the private side are looking for some kind of discount.”
The industrial sector led the way for the remaining asset classes, racking up an investment volume of $665 million. Wong said that the momentum generated by the COVID-19 boost in online retail should continue even after the pandemic becomes a thing of the past.
“Industrial demand has remained strong through this pandemic and will continue to be strong after the pandemic,” he said. “Industrial assets are one of the few that are actually seeing an increase in rents, especially for newer product.”
The apartment sector continued to pull its weight in Q3, generating $575 million in investment, but the office sector, which saw $439 million in investment volume, remains one of commercial real estate’s biggest question marks. No-one can say with any certainty how companies will use office space once a COVID-19 vaccine has been made widely available. People have proven that they can be as productive working from home as they are in the office environment, leading some to wonder if companies will still see value in paying for high-ticket office space in downtown Toronto.
Wong, though, sees offices as necessary. Some business owners are sure to view them the same way.
“I’m a strong proponent of needing office space, especially for social interaction. There are those accidental bump-ins you have with people that create ideas and synergy, and there’s only so much of that you can do over a screen or a phone call,” he said.
Wong sees office investment coming back, possibly at a lower level than was established prior to the pandemic, both in downtown Toronto and in the city’s suburbs.
Mortgage Alliance Commercial vice president Daniela Peeva said the lack of office activity is being driven both by uncertainty on the part of investors and the long, hard looks their prospective properties are being given by lenders.
“The lenders are cautious on office, but they haven’t written down the asset as of yet,” Peeva said.
Commercial lenders, Peeva explained, are putting an investor’s tenants under increased scrutiny. A deal on a downtown office that specializes in renting to law firms, for example, may have been given the green light under normal circumstances, but lenders are now looking at what forms of law are being practiced there. Because of the rise in demand for family law services triggered by the multiform stresses of the pandemic, offices housing such tenants are currently viewed as more attractive by lenders.
“It really depends on the actual tenant,” Peeva said. “They’re digging a little bit deeper into their prediction of what the tenants will experience.”
The good and the bad for commercial mortgage brokers
Peeva told MBN that the downturn in the number of overall commercial transactions has actually been a boon for brokers like herself.
“We experience more business in a downturn in the economy like this. As the lenders get tighter and they stop funding, or they refuse files or close their books, more and more clients come to the broker world to find solutions,” she said. “We’re getting a lot more quality deals and quality borrowers.”
With business booming, the biggest challenge Peeva said she must contend with isn’t client- or lender-related. It’s residential brokers trying to make a quick buck in a space they have no experience with.
She said it is not uncommon for residential brokers to reach out to her and other commercial specialists and offer them 50% of the commission in exchange for doing all the work that goes into putting a commercial deal together.
“Why would I do that? Why would I work, and utilize all my resources and my underwriters, to give you half of the money?” she said. “The brokerage world is full of people who are part-timers who think they can get rich by passing on a client. That’s completely wrong, and it gives a very bad reputation to the broker world because they over-promise and can’t deliver.”
According to Peeva, residential brokers frequently promise their commercial investor clients secure funding through a mainstream or alternative lender, but once they are confronted by the complexities of commercial lending they soon realize that they are in over their heads. They then turn to commercial brokers in the hope that they will take the deal the rest of the way. If these requests are turned down, as they usually are, the unlucky residential broker often has no choice but to take these deals to the private space, where their clients wind up paying considerably more.
“Instead of the client paying 3-4%, he ends up paying 9% because the broker was incapable of bringing the deal into an A lender,” she said.
Rather than jumping in and saving these brokers from themselves, Peeva said she and her team point them in the direction of a lender who may be willing to help them.
“We send them to the right people,” she said. “We don’t want the brain damage if it’s just for a small fee.”
Looking ahead to 2021, Peeva doesn’t see a widespread collapse of the GTA commercial market, though she does harbour some concerns for investors with single-asset class portfolios.
“They might become very problematic, depending on what the asset class is. If it’s one of the troublesome ones – hotel, retail, office; although office remains to be seen – and they invest only in that, I foresee a lot of challenges there.”
